Processing Binary Options in Future Exchange Clearing

ABSTRACT

Systems and methods are disclosed for processing binary options (also referred to as digital options) in existing clearing systems, such as futures clearing systems. The binary option is treated, or processed, similar to standard options on a non-tradeable cash-settled underlying futures contract. A hypothetical instrument, referred to as a book instrument is created to facilitate clearing of the binary option. The book instrument has an expiration date after the expiration of the binary option, such as the day after the expiration of the binary option. For each binary option that expires in the money, a transaction is created for the book instrument future. The underlying book future has an assigned price that is a fixed amount less that the final price for the underlying statistical or actual value of the binary option at expiration. Transactions are loaded in the clearing system and processed and all positions are liquidated.

The present application is a continuation application of U.S. patentapplication Ser. No. 13/862,062, filed Apr. 12, 2013 and entitled“Processing Binary Options in Future Exchange Clearing,” which is acontinuation application of U.S. patent application Ser. No. 13/524,310,filed Jun. 15, 2012 and entitled “Processing Binary Options in FutureExchange Clearing,” which is a continuation application of U.S. patentapplication Ser. No. 12/403,193, filed Mar. 12, 2009 and entitled“Processing Binary Options in Future Exchange Clearing,” which is acontinuation application of U.S. patent application Ser. No. 11/465,028,filed Aug. 16, 2006 and entitled “Processing Binary Options in FutureExchange Clearing,” which claims the benefit of U.S. provisional patentapplication No. 60/803,472, filed May 30, 2006 and entitled “ProcessingBinary Options in Future Exchange Clearing.” Priority is claimed to allof the preceding applications and the entire disclosures of thepreceding applications are hereby incorporated by reference.

Field of the Invention

The present invention relates to clearing positions for expired options,and more particularly, processing binary options as a non-tradeablecash-settled futures contract.

DESCRIPTION OF THE RELATED ART

Clearing processes are performed for derivative products, such asoptions or vanilla options, after an expiration date for the derivative.Derivative products include options on futures contracts, futurescontacts that are functions of other futures contracts, or otherfinancial instruments that have their price related to or derived froman underlying product. A clearing house may process or clear thederivative in a similar manner as for other derivatives, such as inexisting futures bookkeeping systems. The clearing house may break aderivative trade into a series of trades that appear to a member firms'bookkeeping systems as if they are standard monthly options on monthlycash-settled non-tradeable futures. That is, a series of trades are notfutures and futures-options, but may provide the appearance as such sothat they may be easily processed in existing bookkeeping systems.

Binary options, including binary range options, (also referred to asdigital options) are cash-settled options that pay a fixed amount if theoption ends up in-the-money. The payout amount does not depend on theamount by which the option ends up in-the-money. For a binary call, theoption pays if the final value of the statistic or actual value isgreater than or equal to a strike price for the option. For a binaryput, the option pays if the final value is less than the strike pricefor the option. A binary range option may have multiple strike prices,such as a lower and an upper strike price. The holder of the binaryrange option receives (and the seller pays) the fixed payoff amount ifthe final value of the statistic ends up greater than or equal to thelower strike, and less than the upper strike.

Because of the digital or binary nature of the option, existing clearingsystems may not be readily configured to process or clear a binary orbinary range option. To directly process these instruments, systemshandle (a) the different product characteristics—for example, the binaryrange options, with fixed payouts and two strike prices, (b) tradequantities which may be expressed as nominal amounts and very large, and(c) strike prices which may be negative. Therefore, the clearing housewill break up each trade in an actual auction instrument into a seriesof trades that appear to be ordinary options trades, in standard monthlyoptions on cash-settled non-tradeable futures, and should flow throughfirm bookkeeping systems with practically no modifications. Suchprocessing is time-consuming and requires cumbersome decomposition ofthe option.

Therefore, there exists a need in the art for systems and methods forconveniently clearing and processing binary options.

SUMMARY OF THE INVENTION

Systems and methods are described for processing binary options (alsoreferred to as digital options) in existing clearing systems, such asfutures clearing systems. The binary option is treated, or processed,similar to standard options on a non-tradeable cash-settled underlyingfutures contract. A hypothetical instrument, referred to as a bookinstrument is created to facilitate clearing of the binary option. Thebook instrument has an expiration date after the expiration of thebinary option, such as the day after the expiration of the binaryoption. For each binary option that expires in the money, a transactionis created for the book instrument future. The underlying book futurehas an assigned price that is one less than the final price for theunderlying statistical or actual value of the binary option atexpiration. Transactions are loaded in the clearing system and processedand all positions are liquidated. Options exercise and assignmentprocessing is performed in the clearing system as well as an associatedclearing firm bookkeeping system.

Of course, the methods and systems of the above-referenced embodimentsmay also include other additional elements, steps, computer-executableinstructions, or computer-readable data structures. In this regard,other embodiments are disclosed and claimed herein as well.

In other embodiments, the present invention can be partially or whollyimplemented on a computer-readable medium, for example, by storingcomputer-executable instructions or modules, or by utilizingcomputer-readable data structures.

The details of these and other embodiments of the present invention areset forth in the accompanying drawings and the description below. Otherfeatures and advantages of the invention will be apparent from thedescription and drawings, and from the claims.

BRIEF DESCRIPTION OF THE DRAWINGS

The present invention may take physical form in certain parts and steps,embodiments of which will be described in detail in the followingdescription and illustrated in the accompanying drawings that form apart hereof, wherein:

FIG. 1 illustrates a computer network system that may be used toimplement aspects of the present invention; and

FIG. 2 illustrates a flowchart for an exemplary method for clearingbinary options, in accordance with an embodiment of the invention.

DETAILED DESCRIPTION Exemplary Operating Environment

Aspects of the present invention are preferably implemented withcomputer devices and computer networks that allow users to exchangetrading information, such as market data. An exemplary trading networkenvironment for implementing trading systems and methods is shown inFIG. 1.

An exchange computer system 100 receives orders and transmits marketdata related to orders and trades to users. Exchange computer system 100may be implemented with one or more mainframe, desktop or othercomputers. In one embodiment, a computer device uses a 64-bit processor.A user database 102 includes information identifying traders and otherusers of exchange computer system 100. Data may include user names andpasswords. An account data module 104 may process account informationthat may be used during trades. A match engine module 106 is included tomatch bid and offer prices. Match engine module 106 may be implementedwith software that executes one or more algorithms for matching bids andoffers. A trade database 108 may be included to store informationidentifying trades and descriptions of trades. In particular, a tradedatabase may store information identifying the time that a trade tookplace and the contract price. An order book module 110 may be includedto compute or otherwise determine current bid and offer prices. A marketdata module 112 may be included to collect market data and prepare thedata for transmission to users. A risk management module 134 may beincluded to compute and determine a user's risk utilization in relationto the user's defined risk thresholds. An order processing module 136may be included to decompose delta based and bulk order types forprocessing by order book module 110 and match engine module 106.

The trading network environment shown in FIG. 1 includes computerdevices 114, 116, 118, 120 and 122. Each computer device includes acentral processor that controls the overall operation of the computerand a system bus that connects the central processor to one or moreconventional components, such as a network card or modem. Each computerdevice may also include a variety of interface units and drives forreading and writing data or files. Depending on the type of computerdevice, a user can interact with the computer with a keyboard, pointingdevice, microphone, pen device or other input device.

Computer device 114 is shown directly connected to exchange computersystem 100. Exchange computer system 100 and computer device 114 may beconnected via a T1 line, a common local area network (LAN) or othermechanism for connecting computer devices. Computer device 114 is shownconnected to a radio 132. The user of radio 132 may be a trader orexchange employee. The radio user may transmit orders or otherinformation to a user of computer device 114. The user of computerdevice 114 may then transmit the trade or other information to exchangecomputer system 100.

Computer devices 116 and 118 are coupled to a LAN 124. LAN 124 may haveone or more of the well-known LAN topologies and may use a variety ofdifferent protocols, such as Ethernet. Computers 116 and 118 maycommunicate with each other and other computers and devices connected toLAN 124. Computers and other devices may be connected to LAN 124 viatwisted pair wires, coaxial cable, fiber optics or other media.Alternatively, a wireless personal digital assistant device (PDA) 122may communicate with LAN 124 or the Internet 126 via radio waves. PDA122 may also communicate with exchange computer system 100 via aconventional wireless hub 128. As used herein, a PDA includes mobiletelephones and other wireless devices that communicate with a networkvia radio waves.

FIG. 1 also shows LAN 124 connected to the Internet 126. LAN 124 mayinclude a router to connect LAN 124 to the Internet 126. Computer device120 is shown connected directly to the Internet 126. The connection maybe via a modem, DSL line, satellite dish or any other device forconnecting a computer device to the Internet.

One or more market makers 130 may maintain a market by providingconstant bid and offer prices for a derivative or security to exchangecomputer system 100. Exchange computer system 100 may also exchangeinformation with other trade engines, such as trade engine 138. Oneskilled in the art will appreciate that numerous additional computersand systems may be coupled to exchange computer system 100. Suchcomputers and systems may include clearing, regulatory and fee systems.

The operations of computer devices and systems shown in FIG. 1 may becontrolled by computer-executable instructions stored oncomputer-readable medium. For example, computer device 116 may includecomputer-executable instructions for receiving order information from auser and transmitting that order information to exchange computer system100. In another example, computer device 118 may includecomputer-executable instructions for receiving market data from exchangecomputer system 100 and displaying that information to a user.

Of course, numerous additional servers, computers, handheld devices,personal digital assistants, telephones and other devices may also beconnected to exchange computer system 100. Moreover, one skilled in theart will appreciate that the topology shown in FIG. 1 is merely anexample and that the components shown in FIG. 1 may be connected bynumerous alternative topologies.

Exemplary Embodiments

FIG. 2 shows a flowchart for an exemplary method for clearing options.In the method, a binary option may be processed without cumbersomedecomposition into vanilla options.

In an embodiment, a clearing system is used to process an expired binaryoption. The binary option is processed as a standard option on anon-tradeable cash-settled underlying future, also referred to as a“book instrument.” (i.e. it is only to facilitate processing in clearingfirm bookkeeping systems.).

The book instrument is defined to have an expiration date after theexpiration of the corresponding binary option. For example, the bookinstrument may have an expiration date the day after the expiration ofthe corresponding binary option. In other embodiments, the bookinstrument and binary option may expire the same day with the binaryoption expiring before the book instrument.

The non-tradeable underlying future's maturity date may also be set toexpire the business date after the real option expiration date.

On or before the real expiration date, trading ceases for the binaryoption. Option expiration processing for the binary option is not run onthe normal expiration date for the binary option, since the date isdefined in the clearing system according to the book instrument as thenext business day.

On the expiration of the book instrument, such as the day after or intraday after the expiration of the binary option, exactly liquidatingtransfer transactions are created, loaded into the clearing system, andtransmitted to clearing firms for loading into their bookkeepingsystems, for each expired binary option position. For example, if aposition in an expiring option was 35 long by 17 short, then a selltrade for 35, and a buy trade for 17 are created. These transfertransactions are defined as liquidating, either trade by trade (if thatis how the clearing system operates for these products), or implicitlyby specifying an ending position (“position change specification”, orPCS) of zero by zero.

For each binary option position which has expired in-the-money,transactions are created for the underlying “book” instrument future, ata price with a value a fixed amount, such as one, less than the finalprice for the underlying statistic of the binary option:

i) For long call and short put positions, the book-instrument futurestransaction is created as a buy transaction; and ii) For short call andlong put positions, the book-instrument futures transaction is createdas a sell transaction.

The liquidating transfer transactions for all the expired binary optionpositions, and the “book-instrument” futures transactions for thosewhich finished in-the-money, are loaded into the clearing system. Thisin turn causes messages to be transmitted to clearing firms to allow thetransactions to be loaded into clearing firm bookkeeping systems.

As clearing processing continues, no other transactions in these optionsare allowed to clear on that day; no special option instructions(exercise notices or option abandonments) are accepted, nor any positionadjustments or other transaction which could affect the ending optionposition. The net effect, together with the liquidating transfertransactions that have been posted to the expired option positions, isthat all such positions are liquidated.

Option exercise and assignment processing is run normally in both theclearing system and in clearing firm bookkeeping systems for the binaryoption positions, as if they were vanilla options, since the expirationdate in the clearing system has been set to a later date or time, suchas the next business day. However, since all of these option positionshave been liquidated, there are no positions to exercise or assign, evenfor the ones which finished in-the-money. Hence the fact that exerciseand assignment processing is run as if for vanilla options, creatingtransactions at the strike price, has no effect.

At the first clearing settlement cycle of that day, the special futurestransactions for the in-the-money options, created at a fixed price,such as one, less than the final value of the option's underlyingstatistic, are marked-to-market to that final value. This process, whichoccurs in both the clearing system and in clearing firm bookkeepingsystems, causes the binary payout cash flows to occur.

Money calculations for the book instruments, when calculating premiumfor trades in futures options in a bookkeeping system, the trade priceis multiplied by the contract value factor (the multiplier that convertsthe quoted price to its monetary value) and the trade quantity. In otherwords, for futures options, calculate the premium for a quantity of one,then round, then multiply by the trade quantity.

The present invention has been described herein with reference tospecific exemplary embodiments thereof. It will be apparent to thoseskilled in the art that a person understanding this invention mayconceive of changes or other embodiments or variations, which utilizethe principles of this invention without departing from the broaderspirit and scope of the invention as set forth in the appended claims.

1. A futures clearing system comprising: a processor; a user database configured to store information identifying one or more users of the futures clearing system; a match engine configured to selectively match bid and offer prices for a plurality of binary options; a trade database configured to store information identifying prices for the plurality of binary options; an order book module configured to determine current bid and offer prices for the plurality of binary options; and a computer-readable medium containing computer-executable instructions that when executed cause the processor to perform the steps comprising: (a) assigning a book instrument for a corresponding binary option in the plurality of binary options, the book instrument having an expiration after the expiration of the binary option; (b) determining, at the order book module, a price of the book instrument at an expiration date of the binary option; (c) transmitting the price of the book instrument to the trade database for storage; and (c) clearing the binary option according to the book instrument for the binary option.
 2. The futures clearing system of claim 1, wherein (b) comprises determining, at the order book module, a price of the book instrument as an incremental amount of a statistical price for the corresponding binary option at the expiration of the binary option.
 3. The futures clearing system of claim 1, wherein the binary option comprises a binary option contract.
 4. The futures clearing system of claim 1, wherein the underlying instrument comprises a futures contract.
 5. The futures clearing system of claim 1, wherein the book instrument comprises a non-tradeable cash-settled underlying contract.
 6. The futures clearing system of claim 1, wherein the book instrument has a fixed price of one U.S. dollar.
 7. A futures clearing system comprising: a processor; a user database configured to store information identifying one or more users of the futures clearing system; a match engine configured to selectively match bid and offer prices for a plurality of binary options; a trade database configured to store information identifying prices for the plurality of binary options; an order book module configured to determine current bid and offer prices for the plurality of binary options; and a computer-readable medium containing computer-executable instructions that when executed cause the processor to perform the steps comprising: (a) assigning a non-tradeable cash-settled book instrument for a corresponding binary option in the plurality of binary options, the book instrument having an expiration after the expiration of the binary option; (b) determining, at the order book module, a price of the book instrument at an expiration date of the binary option; and (c) clearing the binary option according to the book instrument for the binary option.
 8. The futures clearing system of claim 7, wherein (b) comprises determining, at the order book module, a price of the book instrument as an incremental amount of a statistical price for the corresponding binary option at the expiration of the binary option.
 9. The futures clearing system of claim 7, wherein the binary option comprises a binary option contract.
 10. The futures clearing system of claim 7, wherein the underlying instrument comprises a futures contract.
 11. The futures clearing system of claim 7, wherein the book instrument comprises a non-tradeable cash-settled underlying contract.
 12. The futures clearing system of claim 7, wherein the book instrument has a fixed price of one U.S. dollar.
 13. A system comprising: a processor; a user database configured to store information identifying one or more users of the clearing system; a match engine configured to selectively match bid and offer prices for a plurality of binary options; a trade database configured to store information identifying prices for the plurality of binary options; an order book module configured to determine current bid and offer prices for the plurality of binary options; and a computer-readable medium containing computer-executable instructions that when executed cause the processor to perform the steps comprising: (a) assigning a book instrument for a corresponding binary option in the plurality of binary options, the book instrument being non-tradeable and having an expiration after the expiration of the binary option; (b) determining, at the order book module, a price of the book instrument at an expiration date of the binary option; and (c) clearing the binary option according to the book instrument for the binary option.
 14. The system of claim 13, wherein (b) comprises determining, at the order book module, a price of the book instrument as an incremental amount of a statistical price for the corresponding binary option at the expiration of the binary option.
 15. The system of claim 13, wherein the binary option comprises a binary option contract.
 16. The system of claim 13, wherein the underlying instrument comprises a futures contract.
 17. The system of claim 13, wherein the book instrument comprises a non-tradeable cash-settled underlying contract.
 18. The system of claim 13, wherein the book instrument has a fixed price of one U.S. dollar. 